Foreign Funds Gain Ground

Sept. 24, 2004 -- In their search for higher profits, Americans have been looking abroad.

Mutual funds that invest in international companies have raked in money at a near record pace this year, according to Financial Research Corp. Meanwhile, shareholders have been rewarded with returns that have topped domestic stock funds in recent months.

Money managers say it always makes sense to have some exposure to foreign companies in order to diversify portfolios. Now is a particularly good time to look overseas, they say, because economic growth in some areas is stronger than in the U.S., and stock valuations are more attractive. The relative weakness of the dollar provides an added benefit because it boosts gains realized overseas.

International and global mutual funds generated net sales of $51.5 billion through July, approaching the record $58 billion set in 1994, FRC said. Sales should slow over the rest of the second half of the year as the U.S. economy picks up speed, but they will still clock in at nearly $77 billion by year end, the Boston-based fund tracker said.

International and global mutual funds posted higher returns than their domestic counterparts in the 12 months ended in August. Global equity funds returned 12.6% on average and international stock funds rose 18.6% during that span, while the average U.S. stock fund gained 8.8%, data from Standard & Poor's showed.

Funds that invest overseas outperformed U.S. funds through the first eight months of 2004, too, but by slimmer margins. The average international stock fund gained 0.4% through last month, compared with losses of 1.1% for the average global stock fund, and 1.6% for the average U.S. stock fund.

Their performance helps explain the popularity of foreign funds, fund industry observers said.

"Return chasing is a bit of what's happening here," said Kurt Umbarger, a vice president with T. Rowe Price's international unit who provides information on its foreign funds to investors.

Greater gains in foreign stock markets relative to the U.S. added to the allure of international funds through June, said Owen Concannon, an FRC analyst. "Investors usually chase performance, and right now overseas markets are outperforming U.S. markets" in general, he said earlier this month.

Recent figures for several market gauges illustrate that. For example, the Morgan Stanley Capital International Europe, Australasia, Far East Index was up 1.8% for the year through Thursday, while the Nikkei 225 gauge of Japanese stocks had risen 3.2%. By comparison, the Standard & Poor's 500 index, which excludes foreign stocks, had gained 0.15%.

Through June, sales of international and global funds were concentrated in three fund companies -- American Funds, Vanguard and Fidelity -- which accounted for nearly 60% of the industry's inflows during that span, Concannon said. American's funds feature good performance and low costs, which tends to make them popular with financial advisors who sell funds, he added.

Vanguard also benefits from its funds' low expenses, as well as the popularity of its index funds, Concannon said. The company closed one of its international funds -- Vanguard International Explorer (VINEX) -- to new investors last month because it had taken in about $500 million since mid-January, swelling its assets to $1.4 billion.

Fidelity attracts a lot of money because it's global and international funds perform well, and because it offers a wide variety of them, Concannon said.

Interest in global investing has also helped niche international managers First Eagle and Julius Baer, according to Concannon. In 2003, those companies posted $6 billion in net sales, while accounting for about 15% of the inflows into international equity funds, he said.

Although more money has been moving into funds that invest in foreign stocks, the number of funds had fallen from a peak of 1,006 in 2000 to 747 at the end of August, FRC said. Many fund companies have been liquidating foreign funds, or merging them into other, larger offerings in recent years, it said. FRC attributed the reorganizations to earlier poor stock market performances around the world, which weakened fund performance and cash inflows.

Vanguard generally recommends that investors keep up to 20% of their assets in stocks outside the U.S., including emerging markets, said Catherine Gordon, a company principal who heads its investment counseling and research department.

"It's a meaningful percentage of the equity allocation" in that "it will provide a diversification benefit over time, but won't add an additional risk factor," said Gordon, whose unit sets asset allocations for customers that Vanguard manages money for.

Fidelity recommends that investors keep 10%-15% of their stocks in foreign companies, said Philip Bullen, a senior vice president responsible for international investing.

Bullen and other observers noted that foreign stocks represent a larger portion of the total value of global markets than they did a few years ago. By overlooking this "huge pool of equity assets, you're ignoring a vast" number of potentially good investments, he said.

Standard & Poor's currently suggest investors keep 10% of their assets in foreign stocks. That will provide diversification and also enable people to "take advantage of fast-growing markets in Asia," said John Krey, a senior investment officer with the company's Investment Advisory Services unit, which sets asset allocations for customers.

Clas Olsson, a manager of international funds with AIM Investments, noted that in recent years, many investors have argued that there is no reason to invest abroad because U.S. and foreign markets tend to move in lockstep. But statistics show that correlation tends to be cyclical and, more important, it increases significantly in bear markets, like the one that plagued U.S. stocks from 2000 to 2003, he said.

To put together a portfolio that can compensate for markets moving in the same direction at the same time, "you want to make sure that you get exposure to international small-cap stocks, as well as emerging markets," said Olsson.

While overseas investing can be more rewarding than sticking with domestic companies, it can also be more dangerous because of political risks and changes in the value of currencies.

Also, funds that invest in foreign stocks have higher expenses than those that focus strictly on the U.S. The average global equity fund currently carries an expense ratio of 1.77%, versus 1.66 for the average international fund, and 1.5% for the average U.S. stock fund.

In addition, regulatory and accounting standards abroad can be less stringent than those U.S. companies are subject to. But fund company representatives say this is less of a problem now than it was a few year ago, because foreign standards have been tightened. "You have greater transparency than you did," Bullen said, referring to financial results reported by companies.

David Joy, vice president of capital markets strategy at American Express Financial Advisors, who sets asset allocations for its Portfolio Builder series of asset allocation funds, believes foreign investing has become more popular in recent years because a proliferation of investment-related media has made more information about the performance of international companies and markets available.

"It's not as exotic a concept as it might have been thought to be ten years ago," he said of investing abroad.

2004 Top-Performing Global Equity Funds*

Year-to-Date Return Through 8/31/04 (%)

Three Year Annualized Return Through 8/31/04 (%)

Star Rank

Expense Ratio (%)

Ivy Fund:Cundill Global Value Fund/Adv (ICDVX)

+11.5

+9.4

5

2.12

Tweedy Browne Global Value Fund (TBGVX)

+10.1

+5.5

4

1.39

Polaris Global Value Fund/Investor (PGVFX)

+6.8

+17.0

5

1.75

AIM Global Equity Fund/A (GTNDX)

+5.2

+9.4

5

2.00

First Eagle Global Fund/I (SGIIX)

+5.0

+18.0

5

1.06

2004 Top-Performing International Equity Funds

Year-to-Date Return Through 8/31/04 (%)

Three Year Annualized Return Through 8/31/04 (%)

Star Rank

Expense Ratio (%)

iShares MSCI Australia Index Fd (EWA)

+27.3

+16.2

4

0.84

DFA Invest Grp Japanese Small Company Port (DFJSX)

+21.4

+14.0

5

0.75

Metzler/Payden European Emerging Markets Fund

+17.8

N/A

Not Ranked

0.95

US Global Accolade Fds:Eastern European Fund (EUROX)

+17.3

+42.1

3

2.90

Vontobel Eastern European Equity Fund (VEEEX)

+15.9

+33.5

1

2.94

*Includes exchange-traded funds.

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Data as of 8/31/04.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

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